I am usually not a fan of ‘average’ real estate companies. Their return on assets is usually a meager 5-7% and the only way they can generate a meaningful return on equity is through leverage, which is a double edged sword.
The Israeli-Arab market
Approximately 20% of Israel’s 10 Million citizens are Arab citizens of Israel, or Israeli-Arabs.While most Jews live around central Israel (Tel-Aviv and neighboring cities), Israeli-Arabs tend to live in mostly separate communities in eastern, northern and southern Israel.
In the last few years the Israeli-Arab population has made remarkable progress. The number of Israeli-Arab bachelor-degree students has grown by 80%, 15% of all Israeli doctors are Arab, and the number of Arab tech workers and computer science students has grown by more than 60% in the last 5 years.
Israeli-Arabs mostly live on land historically owned by their families, often for generations, on which they build houses divided amongst the growing family tree. In the arab community in Israel there is a Taboo against selling family land, even for prime location land and even if the land is not being used.
Since Arabs live on family land they don’t spend money on rent or mortgage, which leaves a lot of money for spending even on a modest salary. The problem is there are basically no shopping centers in or around Arab settlements and cities, including ones with a populations of tens of thousands, or even more than 100,000 (Rahat is a good example, a city of 70,000 with no shopping center. RANI is building a shopping center in Rahat that is due to be opened in 2021).
Why are there almost no shopping centers? because the land needed for a shopping center which is at least an acre or two in size, is spread among many families, none of which is willing to sell or has any experience in building or managing a malls or shopping centers.
And so, Israeli-Arabs have had no choice but to drive tens of kilometers weekly to the mall in the nearest ‘Jewish’ city for necessities, fashion and spending their considerable available income (again – no rent or mortgage). It is thought that a considerable part of some malls’ income comes from Israeli-Arabs that often live more than 30 kilometers from the mall.
To add to the problem – since Israeli Arabs tend to divide the the family real estate among their expanding family unofficially, and don’t register or even have any address.Therefore, it is difficult or even impossible for Israeli-Arabs to shop through the internet, since the order can’t be delivered to them.
Things have been like that for decades, until Rani Zim entered the picture.
Meet Rani Zim
Rani Zim Shopping Centers is managed by Rani Zim (the person) and Yoav Kaplan.
Rani started his career in retail at the age of 15, starting a mini-market with his brother Adi, which they later turned into a chain of discount supermarkets that they sold in 2012 for 350 Million ILS.
Another of Rani’s retail achievements has to do with retail is Israeli Office-Depot, a chain that has changed hands from businessman to businessman trying to turn it around. They all failed, until Rani succeeded in making it a thriving, profitable chain.
This Forbes article offers some great background reading on Rani, I especially like this part, which tells you a lot about the kind of man he is:
As we said, Israeli-Arabs are not willing to sell land, but Rani not only overcame this problem – he turned it into a competitive advantage.
Doing real estate differently
Before we get to RANI’s modus operandi, Let’s imagine Moshik, an average shopping center entrepreneur. Moshik, like his many competitors, constantly looks for a location where there would be a demand for a shopping center. Moshik finds 2 acres on which he could be a power center that would generate an NOI of 14 Million ILS, so discounted at 7% this power center would be worth 200 Million ILS.
Moshik negotiates with the land owner (who often get offers that bid up the property) and consults with experts. Moshik manages to convince the landowners to sell the land for 120 Million ILS, and estimates the construction will cost 60 Million ILS (from my research a 2:1 ratio in land to construction is a common rule of thumb).
So Moshik’s total cost is 180 Million ILS. Let’s ignore additional costs (like land tax) and If all goes well then at the end of construction Moshik will get an appraiser to appraise the property at 200 Million ILS and register a profit of 20 Million ILS. If he holds the property the rent yield on his total cost (ROIC) would be 7.77% (14 NOI /180 cost). To increase his return, Moshik may take out a loan of 100 M ILS at say 3%, increasing his return on invested equity to 13.75%.
Now let’s talk about Rani’s way of doing a similar deal. Rani finds a Arab settlement with a ~50,000 with no shopping center. Since no one is selling land there are no other bidders and no competitors, but how does Rani solve the problem of no land for sale? A land big enough for shopping center is probably divided among a dozen of families, and they are unwilling to sell even for a huge payday and even though the land is basically used for, as we say in Israel, “growing cucumbers”. But if you COULD get the land, your shopping center would basically be a local monopoly, with a huge foot-traffic and sales per sqm.
So what does RANI offer? Rani and Yoav personally sit down with each family (Rani and Yoav both speak arabic) and offer them the following deal:
RANI will lease the land for 50 years (divided to 2 periods of 25 years for tax reasons) and will build a shopping center on it. In return, the landowners will get, as rent, 25% of the NOI the shopping center generates. After 50 years the lease will end and the shopping center will be owned by the landowners (or, more likely, their grandchildren), making them quite wealthy. Since Arabs are used to thinking in terms of generations – this is an appealing offer, especially for unused land.
The process of negotiating with the landowners takes months and even years, and builds on the trust RANI earned in the Israeli-Arab community. RANI’s shopping center brand is called SEVEN, and is very well know in the Israeli Arab community.
So what makes this model so appealing? Let’s play the scenario out.
RANI builds a shopping center at the same cost as Moshik (from the example above) – 60 Million ILS. RANI, on the other hand, doesn’t pay for land in advance, so his total cost is 60 Million ILS. Another advantage is that the renters are the ones that pay the land tax, but since they usually don’t have enough money RANI will give them a no or low interest loan to pay the taxes, and deduct the loan from the rent.
What does Rani get? 75% of an NOI of 14 Million ILS (let’s ignore the fact it would probably be higher, being RANI’s center is a local monopoly), so 10.5 Million ILS. This means RANI gets a return on investment of 17.5% before leverage! Economically, RANI’s shopping center is worth almost exactly as much as Moshik’s, but he only paid 60 Million ILS out of pocket to get it. The fact that RANI has to give the landowners the center after 50 years has basically no economic significance from a DCF standpoint.
When considering leverage, things get even crazier than that. RANI could take a loan of 100 M ILS on his rights and be left with more money than he paid on day one (!) plus 75% of NOI after management fees for 50 years (!!)
RANI already has 6 shopping centers, with 5 more to be completed by the end of 2021. Since most arab centers are relatively small, the construction usually takes less than a year.
Considering the method RANI operates – leasing land for 50 years and achieving an extremely high (or infinite) ROE on said investments, it could be said RANI’s most valuable assets are the very assets that enable this modus operandi; the assets that only RANI, and not their competitors, can generate – The contracts with the land owners.
These contracts are extremely valuable. In fact, in terms of DCF ,a 50 year lease is worth almost exactly as much as owning the land itself, and since RANI has a pipeline of such land worth Billions, then the contracts themselves are worth a similar sum (with an appropriate discount, of course).
The interesting part, though is that these leases that are worth staggering sums of money, they are registered on RANI’s balance-sheet AT ZERO (since they have no cost except paper and ink, but they definitely have value).
Therefore, When RANI finishes a project on a leased land and gets an estimator to do a DCF and value RANI’s rights, tens and even hundreds of Millions suddenly appear on the balance sheet “out of nowhere”. Of course, these assets have always been there, you just had to read between the lines.
in the arab market there is very little competition. The way RANI operates and convinces so many landowners to agree is practically a trade secret, and trust in the Arab community isn’t easy, and takes years to build.
RANI currently has working 6 centers, with 5 in the pipeline. In interviews Rani said they identified potential locations for at least 30 more shopping centers in Arab communities. RANI also has other projects besides shopping centers. For example, RANI announces agreements to rent 17 acres of land to build a much needed medical and tech employment center near Sakhnin and few other arab cities that sorely need it. This project is built in the same model we talked about before, and is expected to generate a return of 14% on a cost of 1 Billion ILS. Since commercial real estate in Israel is usually discounted at 5-7%, This project would be worth 2-2.5 Billion on the day it is completed. Orders of magnitude above RANI’s market cap.
so far in the current crisis shoppers have been leaving closed malls and moving to open shopping centers, like RANI’s. Therefore, even at the height of the corona crisis RANI’s renters have been seeing stable or even increased proceeds compared to the same period last year.
RANI even sold, at the height of the crisis, half of an unfinished project in Ganey-Tikva (a jewish majority city in central Israel) for 110 Million ILS an equity profit of more than 50 Million ILS.
Despite that, RANI declared management forego 25% of their salary in 2020.
RANI installs solar panels on fields near his centers and on the centers’ rooftops. The electricity is sold directly to the renters that pay the usual electricity rate in Israel, which generate an extremely high ROE as well.
RANI announced, at the end of 2019, a plan to reach 40 MW production of PV electricity within 30 months (so -mid 2022). I expect these projects will generate, at a rate of ~0.45 ILS per KWH and the Israeli average of 1,700 daylight hours of 100% PV production a year, an NOI of approximately 25-30 Million ILS by 2022.
These are some chosen financials from RANI’s latest balance sheet- Q1 2020:
Cash and ST financial assets: 46 M ILS
Real estate partnerships: 101 M ILS
Real estate: 547 M ILS
Real estate projects in construction and down payments: 248 M ILS
Debtors, Deferred Taxes, Equipment, related parties, a right of use asset, customers: 29 M
Total Asset Side: 971 M ILS
Short term debt (banks, bonds etc): 127 M ILS
Other short term liabilities: 25 M ILS
Long term debt: 327 M ILS
Deferred taxes: 66 M ILS
Other long term liabilities: 3 M ILS
Equity: 422 M ILS
Equity +Deferred Taxes: 488 M ILS
Net debt to assets: 42.1%
Rani’s current run rate NOI is about 50 Million ILS with an FFO of about 25 Million ILS. The reason for this difference is that RANI is an entrepreneurial company and much of its staff and debt is related to ongoing projects.
By year end of 2022 RANI and is projected to reach an NOI of ~120-140 M ILS and an FFO of 70-90 Million, and that doesn’t even include the >1 Billion ILS employment and medicine center in Sakhnin.
Rani currently trades at ~520 Million ILS with low leverage. If we compare “RANI 2020” with an NOI of 120 Million ILS plus hidden assets to another real estate company, Mega Or, with a current NOI of 169 Million ILS and a higher leverage than Rani (52.6% net debt to assets in Mega Or vs 42% in RANI, not including RANI’s hidden assets). Mega Or currently trades for 3 Billion ILS (!) and in my opinion RANI 2022 will be, in many ways, a better company than Mega Or 2020, with dozens of centers in the pipeline in RANI’s unique market and unique way of operating, that competitors just can’t mimic.
Therefore, I see Rani at the very least as a 2X, or even 4-5X investment in the coming 2-3 years, with at least a decade of high growth ahead, together with the advancement of the Israeli-Arab market.
I, and the fund I manage, hold shares in RANI.
Nothing in this article constitutes investment advice and all content is subject to the copyright and disclaimer policy of the Israel Value Blog.